Attorneys Audit Technique Guide NOTE: This document is not an official pronouncement of the law or the position of the Service and cannot be used, cited, or relied upon as such. This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date. Revision Date - March 2011 Table of Contents Chapter 1 - Overview of Attorney Returns ......................................................................... 3 Introduction ..................................................................................................................... 3 RecordKeeping ............................................................................................................... 4 Bank Accounts ................................................................................................................ 5 General Trust Account ................................................................................................ 6 Segregated Trust Account ........................................................................................... 6 Other Revenue Sources ................................................................................................... 7 Client-Related Expenses ................................................................................................. 7 Attorney-Client Privilege ................................................................................................ 8 General Rules .............................................................................................................. 8 Fee Arrangements and Client Identity ........................................................................ 9 Summonses ............................................................................................................... 10 Information Reports ...................................................................................................... 11 Summary ....................................................................................................................... 12 Exhibit 1-2 Attorney-Client Privilege ........................................................................... 13 Chapter 2 - Audit Steps ..................................................................................................... 15 Pre-Contact Analysis .................................................................................................... 15 Accurint Searches ..................................................................................................... 15 Internet Searches ....................................................................................................... 16 Web Currency and Banking Retrieval System (WEB CBRS).................................. 16 Return Preparer Listings ........................................................................................... 18 IRP Transcript ........................................................................................................... 18 Comparative Analysis ............................................................................................... 18 Information Document Requests .................................................................................. 18 Initial Interview ............................................................................................................. 18 Exhibit 2-1, Sample Information Document Request (IDR) ........................................ 21 Exhibit 2-2 Bank Document Request List .................................................................... 22 Exhibit 2-3 Interview .................................................................................................... 24 Chapter 3 - Audit Issues .................................................................................................... 28 Gross Income ................................................................................................................ 28 Introduction ............................................................................................................... 28 Gross Income Types ................................................................................................. 28 Client Trust Accounts ............................................................................................... 30 Noncash Sources ....................................................................................................... 30 Cash Payments .......................................................................................................... 31 Constructive Receipt ................................................................................................. 31 Expenses ....................................................................................................................... 32 Entertainment, Promotion and Advertising .............................................................. 32 Travel ........................................................................................................................ 33 Disguised Hobbies .................................................................................................... 33 Corporate Expenses .................................................................................................. 33 Depreciable Books and Periodicals .......................................................................... 33 Advanced Client Costs .............................................................................................. 34 Page 1 of 52 Employee Versus Independent Contractor Issue .......................................................... 39 Corporate Officer is an Employee ................................................................................ 43 1099 Issues: ................................................................................................................... 43 Form 8300 Issue ............................................................................................................ 43 Related Entities/Taxpayers ........................................................................................... 44 Corporate Taxpayers ................................................................................................. 44 Corporate and Individuals ......................................................................................... 44 Personal Service Corporation Accounting Periods and Tax Computations ................. 45 Exhibit 3-1 Client Costs and Advances ........................................................................ 48 Exhibit 3-2 .................................................................................................................... 49 Exhibit 3-3 20 Common-Law Factors/Rev Rul 87-41 .................................................. 51 Page 2 of 52 Chapter 1 - Overview of Attorney Returns Introduction The right to practice law as an attorney is contingent on being admitted by a state and/or federal bar. These requirements differ from state to state. Typically, a law degree from an accredited law school is required to sit for the State Bar examination. On passing any required examinations and satisfying any other requirements, such as a background check or committee review on character and fitness, the applicant is licensed to practice law. Some courts have additional requirements an attorney must satisfy in order to appear before them. For example, practice before the U.S. Supreme Court requires an attorney to have been admitted to practice in the highest court of a State, Commonwealth, Territory or Possession, or the District of Columbia for a period of at least three years immediately before the date of application; must not have been the subject of any adverse disciplinary action pronounced or in effect during that 3-year period; and must appear to the Court to be of good moral and professional character. The attorney also must have the personal recommendation of two attorneys already admitted to practice before the Supreme Court. Each federal or circuit court establishes requirements to practice, as do special courts, such as the U.S. Tax Court and the U.S. Court of Claims. In the United States, attorneys practice their craft in a variety of ways. Some work as employees for government agencies, or serve as in-house counsel for larger corporations. Also, a large number of attorneys are self-employed, operating their own sole proprietorships, alone or in a shared expense relationship with other sole proprietors, or as partners or shareholders of larger law firms. This guide will assist you in examining an attorney’s tax returns. Examining an attorney’s return is not unlike the examination of any other business. However, examiners may need to address different issues depending on an attorney’s area(s) of expertise. For example, personal injury attorneys typically work on a fee contingency basis. This means that the attorney is paid a percentage of the amount recovered by their client. This percentage may vary depending on the outcome of the case. Typically, an attorney would earn a lower percentage for a case that is settled out of court rather than taken to trial. Examiners should also be aware that, depending on the attorney’s specialty, clients might pay a large portion of their fees well in advance. This should be taken into consideration during the examiner’s pre-planning activities.